Tuesday, November 6, 2012

Samuel Ciszuk is a consultant with KBC Advanced
Technologies, and is one of the leading analysts on Middle East oil. He is
regularly quoted in the press for his insight on Iraq’s energy industry. Below
is an interview with Ciszuk about the Kurdistan Regional Government’s (KRG) oil
policy, and its relationship with Baghdad and Turkey. His views come at an
important time as major energy companies are moving into Kurdistan, and a new
deal has just been worked out between the regional and central governments over
oil exports.

Environment In
Kurdistan

1. The Kurdistan
Regional Government (KRG) and Iraq’s Oil Ministry have taken different
approaches to developing the country’s natural resources. One is that the KRG
offers production sharing agreements (PSAs) rather than Baghdad’s technical
service agreements (TSAs). Can you explain the advantages of PSAs?

The main advantage of PSAs over TSAs is
that the PSAs provide the international oil company (IOC) with a defined share
of the production or you could say reserves, which the company is guaranteed to
get, which is why opponents still brand it as ownership of reserves. This means
that IOCs can put the share of the reserves they will be able to produce during
the duration of the contract down as an asset on their balance sheet,
benefitting company valuation (shareholders/share price) and that they can take
out bank loans with the share as collateral.

The latter is very important, as under
the TSAs the companies will have to undertake the massive projects without
being able to raise debt to finance them. Hence only very large companies are
able to undertake these projects, as they can raise billions in any case
elsewhere, and invest into the projects.

Another important difference is that
PSAs offer flexibility. The share remains the same, regardless of whether
project costs and/or oil prices go up or down, removing at least one level of
uncertainty. The TSAs offer a fixed fee, more or less as one would pay a
company to repaint one’s house, for a job, which will take many years and hence
risks being squeezed by project inflation or general inflation, for instance.

2. Another difference
between the two is the business environment and bureaucracy. Why have companies
said those two factors are better in Kurdistan?

The Iraqi Kurdistan legal framework is
a relatively recent creation, and has been set up with investor attractiveness
in mind, given the need of the region to emerge from the isolation of the 90s,
and build a viable private sector-oriented economy almost from scratch. The
Iraqi legal framework on the other hand carries the legacy of decades of
socialist, statist economy, and from the 90s also a deep lack of international
business interaction. The same can be said about the respective bureaucracies.
In particular in Iraq’s case, the lack of experience in dealing with
international private companies has proven to be one reason why things move
slowly, as the “culture” of the bureaucracy has been if not anti-business, then
at least not really been used to fathom business logic.

3. Are those the
reasons why major IOCs like Exxon, Chevron, Total, and Gazprom have recently
decided to invest in Kurdistan? Are there other factors at play?

No and yes. The reasons why IOCs
–including super majors- enter an area is because they sense/see hydrocarbon
opportunities there of a scale attractive to them. Hence, as the initial
wildcatters proved up significant reserves, larger and larger companies got
interested. For an oilfield/potential oilfield to register on the radar of a
super major, it has to be much more substantial than for a minnow.

Yes, because the uncertainties in Iraq
(cost inflation, slow bureaucracy, shortages of skills, overregulation) are
keeping margins very tight, while opportunities in the KRG look more
reasonable. At the same time, no super major has yet abandoned an upstream
project in Iraq proper.

Particularly when you compare Iraq’s
last exploration auction in May 2012, which had very few takers in the
licensing round, particularly not any experienced ones, to the KRG ones, it is
clear that it makes little sense to explore in virgin areas of Iraq, when one
can go to the KRG. This is even as the potential volumes to discover likely are
much larger in for instance western Iraq than in the KRG. The difference boils
down to the flexibility issue between the contracts. When you add the
uncertainties about whether you will find anything, what you will find
(oil/gas/NGLs), and how much of it, to a TSA, it is very hard to make it work
economically.

IOCs in Kurdistan

4. The KRG has only
been able to export three times after deals with Baghdad. If companies there
can’t export, what kind of work are they doing in Kurdistan?

IOCs have so far largely undertaken the
initial work programs/spending they committed to when signing their contracts.
Drilling a few wells and –hopefully- firming up reserves. Some have then more
cautiously moved on to do further appraisal, but weary of the fact that they
look unlikely to be able to monetize as things stand. Only the earliest players
have built production capacity, and it is looking like the boom in many ways is
slowing down as more and more companies are reaching development stage, but are
cautious to start pouring money into expensive production facilities, which
might then be left standing and gathering dust.

Also, the size of many companies which
entered the KRG in the past years was quite small, so many of them are running
out of money now, and would normally have sold off/farmed out their assets by
now, but the number of buyers has been limited given the legal risk, hence
prices have been low.

5. In the three
agreements with the central government it only paid companies for their costs. What
kind of payments do the companies get from the KRG?

They get a percentage share of the
production, which is calculated after costs. Effectively it is a share of the
profit.

6. Are the IOCs
mostly relying upon the stock market to make money off of their investments in
Kurdistan?

Most of them are in need to
sell/farm-out their assets, as they are quite small. In the meantime they might
be able to raise some more money on exchanges.

7. Have the companies
been happy with this situation or have they been complaining about it?

Of course the companies have not been
happy, but who can they complain to. The KRG is making its best to unlock the
dispute, but Baghdad regards the IOCs as having entered into illegal agreements
with a sub-state body, which did not have the authority to sign upstream
contracts. IOCs can only hope that a final solution is compatible to KRG and
their interests.

8. With major energy
companies moving into Kurdistan is there going to be a period of consolidation
with the smaller ones being bought out?

Yes, and in anticipation that this
issue will have to be resolved soon, some large midsize and super major
companies have already moved in, hoping to beat the rush. Should a resolution
be reached which is good from the KRG perspective, asset valuations in the
region should likely rocket.

9. KRG Natural
Resource Minister Ashti Hawrami has continuously talked about the export
potential of the region. At one time or another he’s said that the KRG could
produce 250,000 barrels a day quite quickly, and eventually jump to 1-2 million
barrels. When Kurdistan has been allowed to export however it’s only been able
to pump about 150,000 barrels a day. Can it reach the figures that Hawrami has
talked about in his timeframe or are they meant to push Baghdad or aimed at
attracting more companies to the region?

In
the short term, yes. DNO, which runs the Tawke field in Dohuk province, the
Sinopec-led Taq Taq consortium, and some KRG production from the Khurmala dome,
as well as the small test production from Gulf Keystone’s Shaikan in Dohuk should
be able to lift exports to 250,000 bpd in a few months time. The larger number
is very optimistic, but exploration results have been good, so they should be
able to at least get relatively close to 1 million barrels per day within a
decade.

Naturally
one would expect a bit of “optimism” in such statements, given the need to
attract investment, and also to point to the amount of resources which the
Iraqi government are denying development for the moment. Also, potential
reserve numbers are reported as a span, if you’re “selling investor space” you
might mention the upper figure, which is what oil ministers and politicians
often do. When reserves have been proven, they most often fall somewhere below
the top number. That is not to say that KRG could not find all the crude for
those exports, but let it be discovered and proved first, so to speak.

Baghdad-Irbil Dispute

10. All of the Kurds’
deals have been called illegal by Baghdad, because it claims sole management
over the oil sector. Now that major IOCs are moving into the KRG, some have
argued that this dispute is over with Kurdistan having won. What is your
opinion of the situation between the two sides?

As I touched upon in earlier questions,
I do not think any side has won yet. The entry of super majors has greatly
strengthened the KRG’s hand, but as long as Baghdad controls the monetization
(exports/marketing) the same basic deadlock persists.

The KRG’s hand is stronger in a pure
oil industry perspective these days, but it holds much less sway in the Iraqi
parliament than before the 2010 elections for instance, meaning it is less
certain that the oil law issue, which should –or at least could - resolve the
dispute will be possible to the region’s liking.

11. Baghdad has said
it would place sanctions and blacklist any IOC that went to Kurdistan. Besides
some minor penalties against Exxon, the Iraqi government hasn’t done much else.
Do you think it’s going to take stronger action in the future or does it
grudgingly accept it can’t do much against such big companies?

It is grudgingly accepting, it seems.
Exxon is too large and important to punish as that would completely derail one
of its largest key megaprojects in the south, which will be responsible for
much of the oil production capacity growth in 2013/2014.

Smaller companies have however
previously seen their interests hit. A South Korean IOC/refiner for instance
lost a term contract for Basra Light crude of around 100,000 barrels per day a
few years ago, after its small upstream arm participated in a South Korean
consortium signing up to acreage in the KRG. For a refiner to loose such a base
load on term can be rather damaging to margins as they had to find replacement
crude quickly and that usually costs.

12. The KRG claims
that Baghdad owes IOCs there around $1.5 billion for exports. Do you think the
problems with the money were due to political decisions in Baghdad, the
infamous bureaucracy or other something else?

I think such an issue boils down to
political decision at the highest level, as the deal was negotiated at the
highest levels. If Prime Minister Nouri al-Maliki and Deputy Premier Hussein
al-Shahristani wanted the deal to stand and run smoothly, they would have made
sure the money was transferred from the Finance Ministry. Iraq has not suffered
from a lack of cash in the government coffers, rather there has been too much.
The bureaucracy comes in at another level, like having been too slow in putting
it to use in reconstruction projects, etc. Unless a minister micromanages a process,
it often slows down to a crawl.

13. Can you see the
two sides coming to some kind of more permanent agreement upon exports or are
they just going to continue with short-term, ad hoc arrangements?

As
I have indicated above, I think it might still be hard for the sides to come
together in a compromise. Both sides would be seen as letting down a very
strong popular support base in their respective constituencies if departing
substantially from the red lines both sides have kept so far. And those red
lines remain firmly apart.

At
some point, a permanent agreement will be made, but it might take a few years
of working uninterrupted under an ad hoc arrangement for it to be acceptable,
it is hard to say.

14. What are the
chances that they will finally agree upon a new hydrocarbon law?

Right now, I would not rate the chances
as particularly high, however if Turkey remains committed to a separate crude
export pipe from the KRG to the Mediterranean, Baghdad might feel that it needs
to make some decisive moves to compromise in order to retain some influence in
the region’s oil sector, and indeed economy.

15. Oil production,
exports and profits are taking off in southern Iraq as well. How does that
affect the relationship between the central and regional governments over
petroleum policy?

To some extent it has made it easier
for Baghdad to play for time, as their oil income now is rising rapidly in any
case, making the impact of the shut-in in the KRG look less of a problem.

The tightness of medium/sour crude in
the Mediterranean in the past few months, compared with the plunging Iraqi
production from the mature and mismanaged Kirkuk field however provided a bit
of a wake-up call. As export volumes without KRG contributions fell from around
400,000 barrels per day to around 300,000 barrels per day Iraq could not
fulfill its term contracts, and a queue build-up of tankers off Ceyhan, Turkey
appeared, with waiting-times reaching 21-days in June/July 2012. This could
only be alleviated by the KRG.

16. Do you think the
Kurds independent oil policy is also backfiring by causing resentment amongst
Arab parties in Baghdad making it harder for the two sides to come to any kind
of agreement?

Very much so. The Kurdish autonomy
aspirations have always been viewed with deep suspicions south of their border,
as they are seen as a first step towards secession. Also, we need to remember
that after decades of resource nationalist rhetoric from the government, and a
very tainted history of IOC participation/exploitation before the
nationalization drive, people in the rest of Iraq remain highly skeptical of
IOCs, and quite supportive of the idea that the oil should be controlled
entirely by the central government.

KRG And Turkey

17. The Kurds are
working on a pipeline that’s supposed to be finished in two stages, with the
first to be completed in 2013, and then the second in 2014. Much has been
written about this project. Is this an independent pipeline directly from the
KRG to Turkey or is it going to be an annex to the existing northern
Kirkuk-Ceyhan line? If the latter will that mean it will still be under the
control of the Oil Ministry?

It is still unclear exactly what kind
of project it will be, and it is very early days. In my view, it is hard to see
the first stage being completed before late 2014 by now, and the second before
late 2015. It is my understanding that the pipeline will not cross
Baghdad-controlled territory. In Turkey it might hook up to/run parallel with,
the Kirkuk-Ceyhan pipeline however, but there have been different information
circling.

18. If the Kurds want
their own independent pipeline, it would require the consent of Turkey. What
has Ankara’s policy been on this matter?

Ankara’s recent support for such a
project was a 180-degree turn, as a bilateral KRG-Turkey link would
fundamentally empower the KRG economically and politically and really make them
quite independent (word used cautiously here) of Baghdad.

This is complicated though, as the
project would require a bilateral treaty between a sovereign state, Turkey, and
a sub-state region (KRG) against the clear opposition to its legality by the
KRG’s sovereign national authority. It is hard not to make it look like Turkey
is meddling in another country’s affairs, and encouraging secession. It might
be a very deep bone of contention, and it would be interesting to ask an expert
in international law if it would be possible for Iraq to challenge it, but also
if it would make any difference if Iraq did, as international law only exists
if states “sign up to it”.

I have the impression Ankara has
stepped back on this issue slightly, while it takes stock of the Kurdish issue
and pan-Kurdish sentiment, in the light of what has happened in Syria. There is
a fear that pan-Kurdish nationalism could again rise in the KRG. Barzani’s
efforts to calm the Syrian Kurdish situation, and take control of the Kurdish
regions there through his Syrian-Kurdish allies should be seen in this light,
as he wants to mute the strong anti-Turkish sentiment and the movement wanting
to liberate all Kurdish areas, in order to salvage the Turkey relationship
which the KRG has become so dependent upon.

This has
gone on for years, but outside of government “control” in Turkey. As part of
the rapprochement, Turkish companies were eager to start importing KRG crude.
Also, Turkey has been backing out Iranian crude volumes due to the
international sanctions on Iran, so they have looked to all other possible
suppliers, even if the volumes which the Kurds can truck only is a fraction of
what Iran previously supplied; it still supplies Turkey, although much less, as
Turkey received a waiver.

20. Another factor is
the Kurdistan Workers’ Party (PKK). They have been carrying out a concerted
campaign to attack the Kirkuk-Ceyhan pipeline nearly every month. Would the KRG
still face that threat if it had its own pipeline to Turkey?

Probably.
Hard to know of course, but that link would be a confirmation of the close deal
between the KRG leadership, particularly the KDP, and Turkey. For ideological
reasons, one would expect the PKK to be quite opposed to this, but then
relationships between the different groups are complex.

Transparency And
Corruption in Kurdistan

21. Corruption is an
issue in all of Iraq, and there are stories that the two ruling Kurdish parties
have inserted themselves into all kinds of business deals in the region. Have
they been able to manipulate any of the oil deals or stocks in the companies for
their own personal profit?

As you
mention, there are plenty of stories and over the years questions have been
raised about commission fees, etc. This has even been an issue in the political
debate in the KRG, which, despite the regional democracy’s shortcomings, serves
as a credit of its openness. This is especially so compared to its neighbors,
save Turkey.

22. The KRG’s Natural
Resource Ministry has claimed that its contracts are transparent. Is this true,
because there has been some dispute over whether Kurdistan has fully published
its contracts, and Baghdad has claimed that the KRG has refused to share a lot
of information about its oil deals?

Ultimately
it is a question of perception, but I would however say that the KRG oil regime
is one of the most open by far in the Middle East/North Africa region. It is
perhaps an ironic positive outcome of the dispute, but Iraq and the KRG are now
leading in at least making their respective upstream oil contracts official.
When it comes to marketing there is always the deal sensitivity which means
total transparency is hard, until sometimes with a significant time lag. This
is the situation for Iraq proper too.

23. Oil smuggling has
been an endeavor that the KRG has partaken in for decades. This issue recently
escalated when Minister Hawrami said the Kurds had the right to export
independently any time they want. Why have they continued to do this even when
it had export agreements with Baghdad?

Baghdad has during much of the time not paid the region any
money for the crude it has exported, which probably is as good a driver as any
for smuggling.

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About Me

My name is Joel Wing. I have been reading, writing, and researching Iraq since 2002.
I have appeared in Fareed Zakaria on CNN, the Christian Science Monitor, The National, The Daily Dish Columbia Journalism Review, Mother Jones, PBS’ Frontline, the Center for Strategic and International Studies, the Institute for the Study of War, Radio Free Iraq.
I have been mentioned in the books Iraq: From War To A New Authoritarianism by Toby Dodge, Imagining The Nation; Nationalism, Sectarianism and Socio-Political Conflict in Iraq by Harith Al-Qarawee, ISIS Inside the Army of Terror by Michael Weiss and Hassan Hassan, The Rise of the Islamic State by Patrick Cockburn, Iraq and Crimes of Aggressive War by John Hagan, Joshua Kaiser, and Anna Hanson.
My work has been published in Iraq in AK News, Al-Mada, Sotaliraq, All Iraq News Agency and Ur News.
I have written for the Jamestown Foundation and Tom Ricks’ Best Defense Blog at Foreign Policy, and I wrote a chapter for the book Volatile Landscape: Iraq And Its Insurgent Movements.
If you wish to contact me personally my email is: motown67@aol.com